FTTx Architectures and Why it Matters for the Open Access Debate

1. FTTx Architectures and Why it Matters for the Open Access Debate Marvin A. Sirbu Department of Engineering and Public Policy Carnegie Mellon University sirbu@cmu.edu http://www.andrew.cmu.edu/user/sirbu/

2. Conclusions Up Front • FTTP networks have significant economies of scale •  facilities-based competition is unlikely to be sustainable • Service-level competition can exist over shared network infrastructure • Sharing possible at different levels • Sharing of dark fiber requires attention to fiber layout • There is great variety in the models of sharing which can be found today • A wholesale-only provider is financially viable • It is not necessary to be vertically integrated to be profitable

3. Outline • Models of Competition in FTTP • Alternative FTTP architectures: impact on competition • Economics of FTTP • Economics of a Wholesale/Retail split

4. Outline • Models of Competition in FTTP • Alternative FTTP architectures: impact on competition • Economics of FTTP • Economics of a Wholesale/Retail split

5. Facilities based competition – each competitor builds FTTP network

6. UNE (LLU) based Competition in FTTP • Dark fiber based – network owner wholesales dark fiber • Wavelength based – network owner wholesales wavelengths

7. Open Access based competition – network owner wholesales transport capacity

8. Sharing Network Infrastructure: Summary

9. Examples of Sharing at Different Layers 0 Open access to ducts • Portugal • France • Dark fiber at layer 1 • Stokab in Stockholm • VLAN service at layer 2 • UTOPIA • Amsterdam • Pau

10. Multiple Layer Separation Amsterdam Source: http://www.citynet.nl/upload/Wholesale-bandwidth-Amsterdam-Citynet.pdf

11. Issues and Problems • If you build a wholesale network, will there be service providers? • Kutztown, PA wanted to do only up to layer 2 and couldn’t find service providers to run over the network • Operations finger pointing between wholesaler and retailer • Provo Utah sold its layer 2 wholesale network to a service retailer arguing that integrated operations are cheaper • Economies of scale • Operating company to light the fiber in multiple cities • Axione • Packet Front

12. Outline • Models of Competition in FTTP • Alternative FTTP architectures: impact on competition • Economics of FTTP • Economics of a Wholesale/Retail split

13. Home Run Architecture • Implications for Competition • Physical layer unbundling possible – wholesaler can sell individual fiber • Also supports open access

14. Active Star Architecture • Implications for Competition • Physical layer unbundling is difficult • requires competitors to collocate electronics at remote node • Must provide feeder fibers for each competitor • Logical layer unbundling possible - supports open access

15. Curb side Passive Star Architecture (PON) • Implications for Competition • Physical layer unbundling not possible • Logical layer unbundling possible - supports open access Separate λ’s may be used for Data and video

16. WDM PON • Implications for Competition • Physical layer unbundling not possible • Optical layer unbundling possible – wholesaler can sell wavelengths • Also supports open access

17. Design Considerations in a PON: A Curb-side PON • Both OLTs needed if only one home in each splitter group subscribes

18. Design Considerations in a PON: A Fiber Aggregation Point (FAP) PON • Fiber Aggregation Point PON supports all models of competition

19. How many homes should be aggregated at an Optimal FAP? • OFAP allows deferring investment in OLTs until penetration requires it

20. OFAP as a Real Option to Phase-in New Technologies • OFAP also supports flexibility • in future split ratios - 10 Gbps GPON, GEPON - WDM PONs

21. OFAP Benefits withan Active Star Architecture RT & OLT tobe deployed as needed • Higher utilization of RT and OLT ports • Neighboring homes can be served by different technology generations • Larger serving area

22. Sharing in the “Second Mile” • As video becomes dominated by unicast Video on Demand (VOD) metro aggregation network costs soar • In smaller communities, access to regional transport to a Tier 1 ISP is a major barrier to entry • Retail service providers sharing an FTTH access network may also need to share at the metro/regional level in order to be economically viable. • NOAAnet • There is a tradeoff with distributed video servers • Sharing a content delivery network (e.g. Akamai) may be an alternative. • This requires distributed colo space and interconnection • See Han, S. et al “IPTV Transport Architecture Alternatives and Economic Considerations,” IEEE Comm Mag, Feb 2008 • Lamb L., “The Future of FTTH – Matching Technology to the Market in the Central Office and Metro Network,” NOC 2008. • NSP, “A Business Case Comparison of Carrier Ethernet Designs for Triple Play Networks,”

23. Regulatory Implications • If regulators want to be able to require dark fiber unbundling, they need to require compatible fiber layout • OFAP PON vs curb-side PON • Even larger OFAP for competitive active star • Need for additional feeder fibers for competitors • All architectures support logical layer (“bitstream”) unbundling • IPTV unbundling possible at bitstream layer • If video distributed over a separate wavelength, issues of access to RF multiplex.

24. Outline • Models of Competition in FTTP • Alternative FTTP architectures: impact on competition • Economics of FTTP • Economics of a Wholesale/Retail split

25. Simple FTTH Economics: FTTH Includes Fixed Plus Variable Costs Cost = Fixed + R * Variable $ • e.g. for Verizon YE06 • Fixed=$850 • Variable=$880 Source: http://investor.verizon.com/news/20060927/20060927.pdf Slope = avg cost Fixed costs 0% 100% Take Rate (R = customers / homes passed) Adapted from Friogo, et.al. http://ieeexplore.ieee.org/iel5/35/29269/01321382.pdf

26. Cost Per Subscriber vs Take Rate $1730

27. How Much Revenue to Support FTTH? • One operator estimates $90/month per subscriber • $40 for ongoing services cost •  $50/month to cover capital costs • Assume an average of 10 year lifetime, 5% cost of capital • Fiber lasts 40 years • Electronics lasts five years • $50/month can amortize $4700 • What if Average Revenue Per User (ARPU) is less? • $30/month can amortize $2800

28. Cost Per Subscriber vs Take Rate Percent take rate needed to break even Capital that can be amortized with $50/mo/sub Capital at $30/mo/sub Adapted from Frigo et. al.

29. Cost Per Subscriber vs Take Rate Take Rate Consumers Capital that can be amortized with $50/mo/sub Competition Adapted from Frigo et. al.

30. Economic Implications: • If revenue available to amortize plant is only $30/month, must reach penetration of > 45% •  room for at most 2 facilities-based providers • This analysis understates the problem • No customer acquisition (marketing/sales) cost included • Customer acquisition drives up Fixed costs pushing breakeven penetration higher • Unlikely to see >90% total penetration

31. Regulatory Implications • Facilities-based competition among fiber network providers is unlikely • Economies of scale • Regulators should be cautious of waiving open access requirements in return for investment in fiber • Could lead to remonopolization • At best duopoly competition • If service competition limited to ISPs which own facilities greatly reduced service level competition • Operators will have Significant Market Power (SMP) • Reduced service-level competition raises Network Neutrality issue

32. Net Neutrality • Can third parties compete with vertically Integrated ISPs? Apps + Con- tent Apps + Con- tent Apps + Con- tent

33. Outline • Models of Competition in FTTP • Alternative FTTP architectures: impact on competition • Economics of FTTP • Economics of a Wholesale/Retail split

34. Economic Analysis: Motivating Question • Open Access: Network operator provides wholesale transport to service providers • Do sustainable prices exist for an infrastructure-only provider? • Build a supply/demand model and calculate welfare effects for different industry structure models

35. Structural separation interferes with the ability to price discriminate • Does this make a wholesaler less likely to recover costs vis-à-vis a vertically integrated entity? • Vertically integrated entity • Can sell 7 bundles: Voice, Data, Video, Voice-Data, Voice-Video, Data-Video, Voice-Video-Data • Can set 7 prices • Dark fiber wholesaler • Can sell only dark fiber access • Can set only one price

36. Wholesale Prices and Arbitrage • A dark fiber wholesaler can set only one price • A lit fiber wholesaler can set a price for data or video bandwidth but cannot set a separate price for the bundle • Video bandwidth is sufficient to offer both video and data services to customers, so • Wholesale price of “bundle” bandwidth and “video” bandwidth must be the same

37. Single Service Provider 2-service • Duopoly 2-service • Single Service provider 3-service We have studied 3 models Assumptions • FTTP network only network serving market • Voice services are provided over a separate network • FTTP network used to provide only data and video services • FTTP network only network serving market • FTTP network used to provide voice, video and data service • Market already served by (cable) incumbent when FTTP provider enters • FTTP and incumbent network used to provide only data and video services

38. Two-service model for the Wholesale-Retail Split • Demand Model • Consumers have different willingness to pay for voice, video and data services: Willingness to pay for a particular service can be modeled by a statistical distribution for a particular market • There is correlation between the willingness to pay for voice, video and data for one particular consumer: One can imagine a 3-space where the coordinates of each point give her willingness to pay for voice, video and data services • For simplicity, here we assume everyone wants voice – so our demand model is 2-space, where the coordinates of each point give the willingness to pay for data and video

39. Demand Model.. A Z P3 P2 C B D P3 P1 X1=Homes taking service1 (data) at price P1 (Area BDP1P3)X2=Homes taking service2 (video) at price P2 (Area ACP2P3)X3=Homes taking service3 (video and data) at price P3 (Area ACDBZ)

40. Supply Model • Annualized Fixed cost for wiring up the entire market consisting of X homes = F • Annualized Fixed Cost of installing CPE and drop loop = C0 • Annual incremental cost of providing data service (Service 1) per home = C1 • Annual incremental cost of providing video service (Service 2) per home = C2 • Observation: Marginal Cost of Bundle (C0 +C1+C2) is less than the sum of Marginal Cost of Data (C0 +C1) and Marginal Cost of Video(C0 +C2) • If X1 homes take data service, X2 homes take video service and X3 take both, annual cost of providing service = F + C0(X1+X2+X3)+ C1X1+ C2X2+ (C1+C2)X3

41. Possible Industry Structures • Vertically Integrated entity (Network owner provides retail service) • ‘Verizon’ Model (Profit Maximizing) • ‘Bristol’ Model (Welfare Maximizing) • Structurally Separated entities (Network owner, either by regulation or choice, is only a wholesaler. The retail market is assumed to be competitive/contestable) • ‘Grant County Profit (GCP)’ (Profit Maximizing layer 2 service wholesaler) • ‘Grant County Welfare (GCW)’ (Welfare Maximizing layer 2 service wholesaler) • ‘Stockholm Profit (SP)’ Model (Profit Maximizing dark fiber wholesaler) • ‘Stockholm Welfare (SW)’ Model (Welfare Maximizing dark fiber wholesaler)

42. Model Results • Not surprisingly, if network owner optimizes Social Welfare (e.g. Bristol) consumers are much better off than if network owner optimizes profit • If network owner optimizes profit, THERE IS VIRTUALLY NO DIFFERENCEin profit for a vertically integrated firm or a wholesaler. • The fact that vertically integrated firm has more flexibility to price discriminate is not important since most households subscribe to the bundle, and wholesaler can extract the same rent. • Ifthere is a large fraction of the population with no interest in broadband data, then vertically integrated firm can do 25% better than a dark fiber wholesaler, but still no better than a lit fiber wholesaler.

43. 3 services model shows less than 5% difference Stockholm and Verizon profits F=5x104 C0=8 C1=20 C2=30 C3=5 1= 35 σ1= 10 2 = 45 σ2 = 10 3= 25 σ3= 10

44. Similar profits are attained in spite of a different distribution of subscribers

45. What if There Are Competing FTTP Operators? • If services are identical, classic case of natural monopoly • Firm with higher penetration has lower costs • Ruinous competition • Having sunk cost in fixed plant, each competitor is willing to price at marginal cost •  negative profits • Stable competition can exist only if there are • Differentiated services appealing to heterogeneous customer tastes; or • High switching costs

46. Duopoly Model Results • We assume two operators with similar cost structures, one an incumbent, one a new entrant • Assuming video and data services are sufficiently differentiated between competitors, both can survive in the marketplace • If the new entrant is a wholesaler only, or vertically integrated makes no difference in its profit • An incumbent competing against a dark fiber wholesaler is modestly worse off than when competing against a vertically integrated competitor • Wholesaler’s inability to price discriminate forces competitor to reduce price discrimination and lose profit.

47. Model assumptions and caveats • Retail industry assumed to be perfectly competitive and no entry barriers; retailers make zero economic profit • Revenues derived entirely from end customers, not from application service providers • No economies of scope at retail assumed • Incremental costs, Ci , are the same in both vertically integrated and competitive retail cases • Competition should drive down incremental costs of services • Layer 2 costs, C0, are the same whether supplied competitively or by wholesaler • See above

48. Regulatory Policy Implications • Operators, municipalities or communities that build out FTTP and choose to be wholesalers: • (i) can realize sustainable prices, • (ii) are likely to create greater welfare (due to innovation spurred by retail competition) and • (iii) are just as likely to recover costs (vis-à-vis vertically integrated entities) • Model results contradict claims by operators that vertical integration is necessary to support investment in FTTP infrastructure  regulatory holiday for FTTP investment is unwarranted.

49. Conclusion • What are the different models of competition in FTTP? • Facilities based • Service level (over shared network infrastructure) • Fiber layout affects options for competition • OFAP supports fiber unbundling even for PONs • More feeder fibers required for competition • FTTP networks have significant economies of scale • Unlikely to support multiple facilities-based providers • “Second Mile” sharing also important • A Wholesale Operator can earn profits similar to those available to vertically integrated competitors • It is not necessary to be vertically integrated in order to “earn enough” to pay for the infrastructure

50. For Further Information • http://www.andrew.cmu.edu/user/sirbu/pubs/Banerjee_Sirbu.pdf • http://web.si.umich.edu/tprc/papers/2006/648/Banerjee_Sirbu%20TPRC_2006.pdf • http://cfp.mit.edu/groups/broadband/muni_bb_pp.html